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Japan’s big tax gamble

Tom Stevenson

Tom Stevenson - Investment Director

Today’s 70th anniversary celebrations in Beijing may be grabbing the headlines in Asia but a bigger event for investors is underway across the Sea of Japan in Tokyo where the Government has today launched a big and bold fiscal experiment.


Raising Japan’s equivalent of VAT from 8% to 10% may not sound a big deal but anyone who remembers the last hike in this consumption tax (from 5% to 8% in 2014) will know how significant the move is.

Japan’s fragile economy did not cope well with the last hike - it plunged the economy into a recession. The big fear is that Japanese consumers will respond the same way to the latest squeeze.

Japan is already under pressure thanks to the mounting trade tensions between China and the US. Japan, like Germany, is a trading nation that depends on the free flow of goods around the world. The growth of protectionism and higher barriers to free trade are bad news for these two economic giants.

The case for raising the consumption tax is clear. Japan has spent heavily during the premiership of Prime Minister Shinzo Abe, running up a huge national debt in a bid to provide a jolt to the country’s stagnant economy. Huge investments in infrastructure and loose monetary policy have come with a big price tag - Japan’s debt stands at about two and a half times its GDP. That’s the largest in the developed world.

The consumption tax may be just 2 percentage points, but in a big economy like Japan’s that equates to $46bn a year in extra revenue. That can be spent on supporting Japan’s ageing population and on paying down the national debt. It is too big a prize for the government to resist.

But Japan has shied away from imposing the tax for nearly five years for good reason. The cost of this year’s hike has been estimated at 0.4% of GDP. Again, that might not sound much but it represents a major slowdown for an economy which is currently growing at just 1.3%.

So, the government is keeping its fingers crossed that a series of offsetting measures - incentives to buy cars and houses and discounts on certain items if they are bought using modern electronic payment systems - will keep the economy on track. That, and an expected boost to spending thanks to next year’s Olympics and the ongoing Rugby World Cup.

For investors, the question is the extent to which the bad news is in the price. The Nikkei 225 index in Japan may have doubled since Abe’s election in 2012 but it was starting from a very low base. More recently, Japanese shares have basically moved sideways for a couple of years as investors have worried about rising trade tensions.

This has left Japan as one of the cheapest markets in the world today, on a par with other out of favour regions like the UK and Europe and significantly less highly-valued than the US.

From a corporate perspective, the outlook is not that bad. Company balance sheets are healthy with high levels of spare cash waiting to be put to work, even if that is only to buy back shares. With domestic demand relatively resilient and a tight labour market - a higher jobs-to-applicants ratio than at any time since the 1970s - the economic backdrop is better than today’s valuations might suggest.

The time to get interested in an investment is when you can’t find anyone to say a good thing about it. That is certainly the case today, with regard to Japan, which has fallen off everyone’s radar.

The Select 50 has three Japan-focused funds:

Baillie Gifford Japanese Fund has long been one of our favoured ways of playing this market. Managed by Matthew Brett, the fund has a particular focus on Japan’s technological lead in areas like robotics and automation.

The Lindsell Train Japanese Equity Fund is a relative newcomer to the Select 50. A sister fund to one of our favourite UK funds, this one is managed by Michael Lindsell, a former chief investment officer at GT Management’s Tokyo office. The focus on this fund is on companies with a high and stable return on capital.

Another new fund on our preferred fund list is the Man GLG Japan CoreAlpha Fund. This is managed by another industry veteran, Stephen Harker, who has been following the Japanese equity market since the mid-1980s. This fund focuses on the top 300 companies with a view to picking out of favour shares, with low valuations. A true contrarian play.

Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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What you could do next

Read more about Baillie Gifford Japanese Fund

View the factsheet to see price, charges, performance, details on how the investment's managed, and more.

Read more about Lindsell Train Japanese Equity Fund

View the factsheet to see price, charges, performance, details on how the investment's managed, and more.

Read more about Man GLG Japan CoreAlpha Fund

View the factsheet to see price, charges, performance, details on how the investment's managed, and more.